Preliminary Review of Filings (Audit No. 401)

Us Sec Oig

Informations

• Publié par: Irne
• Nombre de lectures: 20
• Langue: English

Extrait

PRELIMINARY REVIEW OF

FILINGS

EXECUTIVE SUMMARY

The Division of Corporation Finance (Division) conducts preliminary reviews of

filings under the securities laws. These preliminary reviews identify disclosure issues

and help determine whether further review of filings is warranted and the type of

further review. We evaluated the Division’s preliminary review process.

We found that the Division has made some revisions to enhance its preliminary

reviews over the last three years and that further improvements are planned. Most

significantly, the Division plans to focus to a greater degree on the quality of the filing

company, as well as the quality of the disclosure in a filing. We concur with this

proposed change of focus and commend the Division for its efforts.

We are making several recommendations to assist the Division as it continues to

improve the preliminary review process. These include: enhancing consideration of

company risk factors in the preliminary review process, maintaining surveillance of

large companies, and continuing efforts to manage workloads better.

The Division provided comments on earlier drafts of this report. We have reflected

the Division’s comments as appropriate in our report. The Division did not provide

comments on the final version of the report.

SCOPE AND OBJECTIVES

Our audit objective was to determine if improvements could be made to the

Division’s preliminary review process

.

During the audit, we interviewed and

surveyed Division and other Commission staff. We also analyzed filing review data,

relevant guidance, and other documentation.

The audit was performed from January to October 2005 in accordance with

generally accepted government auditing standards, with one exception. Because of

time and resource constraints, we did not evaluate the validity and reliability of data

from three automated systems used by the Division: the Electronic Data Gathering

Analysis and Retrieval (EDGAR) system, ADHOC (not an acronym), and the Filing

Activity Tracking System (FACTS). We are unaware of any material errors

involving EDGAR, ADHOC, or FACTS, or any effect on the results of the audit from

not testing the systems.

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EDGAR is used by public companies to submit their filings and contains

documentation related to filing reviews. ADHOC is a database program which

extracts information from EDGAR. FACTS contains data on filing reviews (

i.e.,

which filings were reviewed, and the date and type of review).

BACKGROUND

Specific information on the preliminary review process is non-public, according to

the Division. As a consequence, we present below only some general information

about the Division and the review process.

The Division has approximately 515 staff (mainly attorneys and accountants), of

which approximately 80% are assigned to one of eleven industry groups (

e.g.,

the

Office of Telecommunications, the Office of Financial Services). The industry groups

are primarily responsible for reviewing filings received from public companies. The

Division also has several support offices, including the Office of the Chief Counsel

and the Office of Mergers and Acquisitions.

Filings are submitted pursuant to the securities laws, including the Securities Act of

1933, the Securities Exchange Act of 1934, and the Trust Indenture Act of 1939.

Some types of filings are usually reviewed, while other types are usually not

reviewed. The main review types are full review (legal and accounting); financial

statement (accounting); legal; targeted (focused on specific issues - also referred to as

a monitor); and preliminary review (the subject of this audit).

The Division normally conducts full reviews on filings representing a company’s

initial entry into the federal disclosure system (

i.e

., initial public offerings of

securities). Contested proxy solicitations, tender offers, and going private filings are

also normally reviewed because they can have a material effect on the interests of

investors.

The preliminary review is the initial review of a filing. It may lead to a more

comprehensive review (such as a legal or accounting review), depending on the

review results. Annual reports from large companies are given a preliminary review

to determine whether further review is warranted. According to the Division, this

review is primarily focused on the company’s financial statements and related

disclosure.

The Division noted that, since 2002, it has replaced what it described as a very

mechanical screening process with a much more substantive preliminary review

process. The Division indicated that, as a result, it has made very substantial

changes in the manner in which it selects companies for further review. Each

industry group has been given more independence in deciding what level of review to

assign to a company filing. According to the Division, this allows the group to

balance its workload effectively and focus on material issues in a greater number of

filings.

Once the preliminary review is completed, the Division’s further review of selected

filings is primarily focused on the full disclosure of material information and

corrections of material deviations from its rules and regulations and generally

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accepted accounting principles. The review seeks to ensure that investors are

provided with accurate and material information, and to deter fraud and

misrepresentation in the public offering, trading, voting, and tendering of securities.

These objectives are designed to allow investors to make well-informed decisions

regarding their security transactions.

The work of the Division has been impacted by passage of the Sarbanes-Oxley Act

(SOX), which contained numerous provisions designed to improve the reliability of

financial statements. SOX increased the Division’s budget, while also imposing

additional requirements on the Division’s review of filings, as discussed below.

AUDIT RESULTS

We found that the Division has been making changes to improve the preliminary

review process. The Division has already implemented several improvements, and

further steps are planned.

The Division has in the past used financial analysis of company performance in its

screening process. It has more recently been testing the usefulness of reports

prepared by a number of vendors. These private reports attempt to identify

potentially problematic companies.

A pilot program in the EDGAR system concerns use of Extensible Business

Reporting Language (XBRL) in filings. This data-tagging technology, if

implemented, should allow the Division to undertake financial analyses and to

determine trends across companies.

As stated in the Background, the Division has replaced what it described as a

mechanical screening process with a more substantive preliminary review process.

The Division intends to enhance this process by focusing to a greater degree on

company quality (in addition to disclosure quality). In our opinion, this broadened

focus should improve the preliminary review process. We commend the Division for

its initiative.

Our recommendations below are designed to help the Division further improve the

preliminary review process. Overall, the recommendations should help the Division

make better-informed decisions during that process regarding what type of further

review, if any, is appropriate.

COMPANY RISK FACTORS

To focus on company quality, the Division will need to consider several risks

involving companies. These include the risk that a company’s financial statements

may need to be restated. To help it analyze company risks effectively, the Division

will need to provide additional guidance on this issue to its staff.

We identified and shared with the Division certain risk-based information that could

enhance the preliminary review process. This information includes financial ratios

and analyses, trading data, and other information.

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The Division agreed that this kind of information could be useful and is taking steps

to further incorporate it in the preliminary review process. Obtaining some of this

material may require enhancements to the information technology available to the

Division.

Recommendation A

The Division of Corporation Finance should enhance its consideration of

company risk factors and other risk-based information during the

preliminary review process, as discussed above. It should consult with other

Commission offices (

e.g.

, the Office of Information Technology, the Office of

the Chief Accountant, and the Office of Risk Assessment), and provide

guidance to its staff, as appropriate (

e.g.

, by including company risk factors

on the Division’s preliminary review sheets).

SCHEDULING REVIEWS

Section 408(b) of the Sarbanes-Oxley Act (SOX) requires the Division to consider

certain factors in scheduling reviews, as follows:

1)

issuers that have issued material restatements of financial results;

2)

issuers that experience significant volatility in their stock price as

compared to other issuers;

3)

issuers with the largest market capitalization;

4)

emerging companies with disparities in price to earning ratios;

5)

issuers whose operations significantly affect any material sector of the

economy; and

6)

any other factors that the Commission may consider relevant.

We found that the Division generally only used the third factor above (issuers with

the largest market capitalization) in determining the timing of filing reviews. A

senior member of the Division indicated that incorporating all of the risk factors has

been difficult, for a variety of reasons (including delays in hiring and training new

staff, a lack of the necessary information technology, and difficulties in initially

developing a methodology for some factors).

The Division indicated, however, that it considers these factors in determining

whether to review a company in a given year. It views the factors as assisting it in

making review decisions over a three-year review cycle, not a one-year period.

The Division further indicated that it has finalized work with the Office of Economic

Analysis on developing a methodology for identifying companies that experience

significant volatility in their stock price. The Division also believes that its industry

specialization allows it to focus on companies in material sectors of the economy.

The Division’s focus on company quality should help it to further implement the

factors listed in Section 408(b) of SOX, since these factors relate to companies, not

individual filings.

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Recommendation B

As it continues its focus on company quality, the Division should further

incorporate the factors in Section 408(b) of SOX into its timing of filing

reviews, and issue appropriate guidance to its staff.

REVIEW REQUIREMENTS

The Sarbanes-Oxley Act, Section 408(c) states that “In no event shall an issuer

required to file reports under section 13(a) or 15(d) of the Securities Act of 1934 be

reviewed under this section less frequently than once every 3 years.”

During its first review cycle under Sarbanes-Oxley, the Division excluded certain

companies from review. These included, but were not limited to, some companies

not required to file periodic reports after the first year (because they registered only

debt securities under a certain amount), and some companies that could deregister

at any time due to a small number of shareholders or a limited asset size. However,

the Division indicated that it did review a number of companies meeting these

criteria during the first three year cycle.

The Division determined that its approach of excluding certain companies was the

best way to carry out Congress’ intent, given its limited resources at the time. With

the possible exception of the excluded companies, the Division stated that it

complied with the three-year review cycle in the Sarbanes-Oxley Act. As resources

permit, the Division plans to review some or all of the excluded companies in the

future.

Recommendation C

In the future, the Division of Corporation Finance should review all

companies subject to Section 408(c) of SOX. If it excludes certain companies

from review (as discussed above), it should seek a formal legal opinion from

the Office of General Counsel to determine whether the exclusion is

permissible under the Sarbanes-Oxley Act. The Division should then take

appropriate action to comply with that opinion.

SURVEILLANCE OF LARGE COMPANIES

The Compliance Inspection and Examination Program (Program) recently

implemented a new examination approach. On an experimental basis, the Program

assigned staff to monitor continuously developments at the largest investment

advisory groups. A similar approach involving large capitalized companies could

help the Division improve its focus on company quality.

For instance, the companies in the Standard and Poor’s 500 Index represent

approximately 80% of the total market capitalization in the United States. The

Division could assign staff to maintain continuous surveillance of developments (

e.g

.

,

corporate press releases, trading data, and 8-K filings) at these companies. Because

of their enhanced knowledge of large companies, the staff assigned to surveillance

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would be better able to identify timely material issues affecting the companies when

they perform preliminary reviews of filings.

Recommendation D

The Division of Corporation Finance should consider implementing a

surveillance program for large capitalized companies, as outlined above.

WORKLOAD MANAGEMENT

Based on our analysis, approximately two-thirds of issuers have a December 31

fiscal year-end. These companies are required to submit their 10-K filings by mid-

March of the following year. The influx of filings from these companies creates a

workload management issue for the Division.

Some industry groups in the Division believe that the large influx of 10-K filings in

mid-March adversely affects the review process. They indicated that companies

with fiscal year-ends other than December 31 may be reviewed more often and more

comprehensively than their risk level would normally warrant (a large workload

peak could also lead to a lesser level of review than warranted for filings made

during the peak).

Our analysis supported the view of the industry groups. Using data from the

FACTS system on 2,750 10-K filing reviews in calendar years 2003-2004, we found

that companies not having a December 31 fiscal year-end received a financial

statement or full review approximately 15% more often than companies with a

December 31 fiscal year-end.

According to many industry groups, the 10-K peak season also influences the timing

of registration and proxy statement filings. However, they do not generally believe

that preliminary reviews of registration and proxy statements are significantly

affected.

The Sarbanes-Oxley Act requires that the Division review each reporting company

at least once every three years. Some industry groups believe that this requirement

also creates a workload peak season because the Commission reports Sarbanes-

Oxley statistics as of September 30, the end of the Commission’s fiscal year.

The Division indicated that the cyclical nature of the Division’s workload due to

difference in fiscal year ends can create pressure on its staff to complete company

reviews quickly. It believes that the workload peak created by the Sarbanes-Oxley

Act review cycle will improve now that the first three-year cycle under SOX has been

completed.

Also, the Commission issued a rule in December 2005 requiring that 10-K filings

from the largest companies be filed about two weeks sooner than before (Release

Nos. 33-8644, 34-52989). This rule should help mitigate the workload peak.

The Division indicated that it believes our concerns will be ameliorated now that it

has completed the first SOX three-year cycle and has established procedures to meet

the review mandate.

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Recommendation E

The Division of Corporation Finance should monitor its workload situation

and identify ways to manage its workload peaks, if those peaks continue.

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